IBDE

By Nasos Mihalakas: Assistant Professor of International Trade Law, New York University, Tirana

EXCHANGE: The Magazine for International Business and Diplomacy      No. 3 March 2011

LAST YEAR we saw developments in the EU-China trade relationship that could signify a greater convergence between these two trading partners. The global financial crisis that led to a temporary drop in western demand for Chinese goods during 2009 was followed by an aggressive investment strategy by China in 2010, acquiring a number of businesses in Europe and promising to purchase euro debt in order to alleviate the euro-zones sovereign debt crisis. The rhetoric coming from China’s leaders indicates that Beijing is certainly worried about Europe’s economic future. But how far is China prepared to go to ensure the euro survives the sovereign-debt crisis? Recent events indicate, not far enough! 

When the Greek government was looking for private capital to finance its government debt in the spring of 2010, China with its huge currency reserves did nothing to intervene. Instead Greece had to go to the IMF for a loan, which caused further panic in the bond market and exposed the financial solvency of other European countries. China’s recent pledges to purchase Spanish bonds as well as statements of financial support for Portugal show that China understands the threat that the European sovereign debt crisis poses to the euro and therefore to global financial stability.  

But while this might indicate a well-appreciated support for the euro, these purchases are mainly symbolic gestures.  Rather, it appears that by signing investment deals with European governments and buying euro-government bonds, China is trying to take advantage of an opportunity, instead of helping support the global financial system by meaningfully guaranteeing the euro’s survival. 

Investment Deals

China's aggressive investment activity came at the same time as credit rating agencies were downgrading Greek and other European bonds to junk status. While the sovereign debt crisis has triggered a plunge in the value of the euro, which has made Chinese exports to the zone more expensive, it has also brought some advantages to Chinese investors. Before the crisis China had made only modest investments in European states, due to the political sensitivities in European capitals.

According to the Heritage Foundation’s “China Global Investment Tracker," China’s non-bond investments in Europe have reached $35 billion, compared to $28 billion invested in the US. China clearly wants an ever greater piece of the European market, and at the moment (due to the sovereign debt crisis that is plaguing Europe) a lot of European countries are willing to overlook earlier hesitations to Chinese investments. 

During the 2010 Universal Expo in Shanghai, a series of European trade missions travelled to Shanghai, trying to woo Chinese investors in an attempt to boost Europe's weakened economies. The Belgian trade mission was hoping to persuade Chinese car manufacturer Geely to add struggling Opel Antwerp to its collection of European acquisitions. In March of 2010, the Chinese carmaker Geely paid $1.8 billion for Ford's ailing Volvo unit. In Sweden - Volvo's homeland - the acquisition triggered some negative comments in the media about China’s acquisition of a European icon.

Other countries were not shy to solicit Chinese investments, including Greece, which used the Expo to hail China's commitment to inject billions of dollars into the country's debt-ridden economy and to invite Chinese companies to set up businesses in Greece. Romania’s business envoys discussed with Chinese bankers and investors a series of projects to allow Chinese money to flow in and buy up the country's struggling industries.

Beijing's response has certainly been positive. The recent investment activity, reportedly the biggest by China in Europe, will enable Chinese corporations to secure controlling stakes in major telecommunications, real estate and shipping organizations. Some of China’s investments to specific countries include:

Italy – During Premier Wen’s visit in October, 2010, China announced 10 commercial investment agreements worth $2.5 billion, covering - among others - the solar energy sector. Furthermore, China’s Cosco is already expanding the port of Naples to be used by Chinese companies exporting to Europe, and HNA (a logistics, transportation and tourism group from China) is in negotiations for the construction of a giant air terminal north of Rome for cargo arriving from China.

France – During President Hu’s visit in November, 2010, France and China signed commercial agreements of $22.8 billion in total value. They included: French nuclear power industrial giant Areva will provide $3.5 billion worth of uranium to the Chinese company CNGPC; China will buy 102 Airbus airplanes; and a joint effort to cooperate in cellular telecommunication worth $1.5 billion.

Portugal – During President Hu’s visit in November, 2010, Portugal and China signed commercial agreements including a joint construction of optical fiber networks by Huawei and Portugal Telekom and a banking cooperation between Millennium and ICBC. 

Ireland – Ireland's business community is working on obtaining approval for a $61 million project to create a Chinese manufacturing hub in Athlone, in central Ireland. The attractions for Chinese investors in the Athlone project are numerous; a manufacturing center operated inside the euro zone will bypass a range of tariffs and quotas levied by the EU on imported Chinese goods while benefiting from a developed infrastructure network and low corporate tax rates.

Sovereign Debt Deals

On the other hand, it is very difficult to ascertain which countries are being supported by the Chinese through government bond purchases. The investment managers at the State Administration of Foreign Exchange (SAFE) (which administers the $2.85 trillion of Chinese currency reserves) devise their strategies behind closed doors and they rarely make public statements. Furthermore, SAFE makes its purchases through intermediaries in London, Hong Kong, and the Caribbean, further disguising their international acquisitions.

More specifically, in July 2010, China spent €400 million on Spanish 10-year government bonds, a rather insignificant amount considering the size of the debt problem in Europe and the size of China’s currency reserves. Over the fall, the EU made permanent the ‘European Financial Stability Facility,’ its 440 billion euro ($570 billion) fund intended to help heavily indebted euro-zone nations raise funds on international markets. China, on the other hand, whose official currency reserves are at a record $2.85 trillion, is considered to maintain an estimated 25% of it in euro’s, or about $710 billion. 

Last month, Spanish newspapers reported that China was ready to buy about €6 billion ($7.6 billion) of Spanish debt, citing government sources. According to the Financial Times Lex Column however, even €6 billion does not buy much in the global financial markets any more.  It is just 5.4% of the size of the 2010 Greek rescue package, a mere 1.1% of the outstanding debt of the Spanish government and a minuscule 0.3% of China’s foreign currency reserves. 

China’s recently increased its Euro-support rhetoric, and even put a token amount of money in the market, by buying €1.1 billion ($1.5 billion) of direct bond purchases of Portuguese debt, and possibly even more in secondary transactions. The temporary euphoria across Europe resulted in a modest jump in the EUR-USD exchange rate from 1.29 on January 10, 2011 (the lowest since September 15, 2010) to nearly 1.38 a month later. 

However, the true motives of the Chinese government might not be as altruistic as they seem. China’s RMB is pegged to the dollar, so the fall in the euro against the dollar has made Chinese exports more costly in the EU. As European governments introduce austerity measures, domestic demand is likely to fall even further, with ripple effects on imports. The EU is China’s largest exporting destination, making up 20% of China’s total exports in 2009, and China needs the EU's currency to be as strong as possible to preserve its imports. 

The Chinese Dilemma

Government bond purchases are a double-edged sword, especially for China. Many argue that China wants to preserve the euro to diversify its holdings of U.S. dollars. But the U.S. Treasury bonds that it owns help prop-up the dollar, against which the renminbi (RMB) is pegged at an undervalued rate in order to boost exports. Diminishing its dollar holdings would lead to a further strengthening of the RMB and depreciation of the U.S. currency.

This is why China simply cannot dump its dollars. Therefore, Europe’s leaders shouldn’t expect anything more than symbolic Chinese support for the euro.  As the euro loses value again, Chinese exports to its largest trading partner will drop, hurting the very part of the economy Beijing is trying to protect with its RMB-USD peg. A euro-zone recession would be bad for Chinese business, and a euro crisis would reduce the appeal of what should be, for Beijing, a helpful alternative to the dollar. However, a hands-off approach to the euro-zone crisis could lead to accusations of a lack of solidarity with its major trading partner, and will undermine China’s assertion that it is a ‘responsible international partner.’ 

For China, there are risks in any policy – which is why Beijing is doing a little bit of everything, thus accomplishing nothing. China says it wants to help the euro, but not at the expense of its cherished dollar peg.